Capital Account Openness Research Articles

Financial and economic determinants of sustainable economic growth in Egypt, Nigeria and South Africa

This study analyzes financial and economic determinants of sustainable economic performance using the quantile regression for the period from 1970 to 2016 for Egypt, Nigeria and South Africa. The main drivers of sustainable economic performance vary among the economies. It is driven by trade openness, government expenditure and political stability in Egypt. In South Africa, the desired threshold for financial development to impact growth is reached. Also, there is complementarity between financial development and trade openness. This proves their advancement at the domestic financial markets in the direction to sustainable economic performance. Interestingly, Nigerian economy’s sustainable growth is enhanced by capital account openness. Policies that will boast intra trade in Africa are encouraged as the AfCFTA has come to spur manufacturing activities on the continent. At the same time, emphasis should be set to improve financial and economic determinants of sustainable economic performance.

State dependence and exchange rate regime choice: a new empirical explanation to the polarization phenomenon

This paper, using the dynamic multinomial choice random effect panel Logit model, and focusing on the intermediate exchange rate regimes, tries to provide new empirical explanations to the special polarization phenomenon. The main findings are as follows: Firstly, the state dependence can influence the choice of exchange rate regimes greatly, and the state dependence can explain the phenomenon of the special polarization. Secondly, the non-state dependence factors influence exchange rate regimes choice of different development stage economies in different manner. The non-state dependence factors can also explain the special polarization. Thirdly, the policy makers will choose the less-flexible exchange rate regimes with the increasing of capital account openness. The intermediate exchange rate regimes can survive and stabilize the economy under certain conditions. Lastly, this paper draws a series of important conclusions and policy implications.

Macroeconomic adjustment with managed exchange rates and capital controls: Some lessons from China

This paper examines the performance of capital controls and exchange-rate management when the economy finds itself in dark corners. These are times when the real sector experiences a sequence of prolonged negative shocks from world demand, while the central bank faces low world interest rates on its foreign-exchange reserve holdings. We examine two regimes, one of a fixed exchange rate with strong capital controls and another with a more open capital account with a managed exchange rate. We show how this model replicates recent experiences of China as it moved from a relatively fixed exchange rate regime with strong capital controls to a more flexible exchange rate regime with a more open capital account. Our results show that capital-account liberalization should be accompanied by domestic price liberalization to avoid large losses in foreign exchange reserve and jumps in unemployment during dark corners in the more open regime.

The Sources of International Investment Income in Emerging Market Economies

We investigate international investment income flows in 26 emerging market countries during the period of 1998-2015. Net investment income registered a deficit for this group of countries of between 2-3% of GDP during this period. This deficit has been dominated by payments on foreign direct investment liabilities, which is consistent with the change in the composition of the external liabilities of these countries. Our results indicate that both capital account and trade openness are associated with the deficits on direct investment income. In addition, there was a small deficit in portfolio investment income, which is affected by the development of domestic financial markets and investor protection. Other investments’ income and the income from foreign exchange reserves have a negligible role in total investment income.

Financial Openness and Capital Inflows to Emerging Markets

We reassess the connection between capital account openness and capital flows in an empirical framework that is grounded in theory and makes use of previously unexplored variation in the data. We demonstrate how our theory-consistent regressions may overcome some ubiquitous measurement problems in the literature by relying on interaction terms between financial openness and traditional push-pull factors. Within our proposed framework, we ask: what can be said robustly about the effect of capital account restrictions on capital flows? Our results warrant against over-interpreting the existing cross-country evidence as we find very few robust relationships between capital account restrictiveness and various types of capital inflows. Countries with a higher degree of financial openness are more susceptible to some, but by no means all, push and pull factors. Overall, the results are still consistent with a complex set of tradeoffs faced by policymakers, where the ability to shield the domestic economy from volatile capital flow cycles must be weighed against the sources of exogenous risks and potential long run growth effects.

China’s capital account liberalization: a ruby jubilee and beyond

ABSTRACTSince Reform and Opening-up in late 1978, China has gradually opened many parts of its capital account, but the progress has been slower and bumpier than its current account liberalization. We review China’s four decades of capital account opening-up through the lens of three recurring debates. First, how open is China’s capital account and how much more needs to be done? Second, how committed is China to opening its capital account? Third, is China ready, and how to liberalize its capital account further? From China’s experience we draw good, bad, and ‘ugly’ lessons that answer to these three debates, and shed light on China’s capital account policy going forward. We conclude that policymakers are committed to opening up China’s capital account further. With the capital flow management framework upgraded, the challenge lies in coordinating capital account liberalization with financial and exchange rate reforms. The troika of a near-fully open capital account, a flexible exchange rate, and monetary independence best serves China’s long-term interests.

Pain or Gain? Chinese Experience of Capital Account Liberalization

AbstractThe neoclassical growth model predicts that capital account liberalization could potentially enhance economic performance; however, there is no consistent empirical evidence to support this positive association. Using a novel dataset of Chinese capital account openness, this paper demonstrates a positive relationship between capital account liberalization and aggregate economic performance. The difference‐indifferences method is used to capture the causal effect of capital account liberalization on economic performance by taking advantage of variations in both external financial dependence and the progress of capital account openness. We investigate three channels that could strengthen this positive relationship using a firm‐level dataset. We find that capital account liberalization could: (i) alleviate the degree of resource misallocation, and this effect is more significant in industries relying heavily on external finance and in regions with more favorable business environments; (ii) enhance firms’ total factor productivity; and (iii) promote innovation. Our findings suggest that a strategy of gradual openness will leave some leeway not only for improvement in domestic markets but also to mitigate exposure to unfavorable global shocks.

The effect of inflation targeting and financial openness on currency composition of sovereign international debt

This paper analyzes the joint effect of inflation targeting and capital account openness in promoting changes to the currency composition of sovereign international debt in developing countries. First, using difference-in-differences in combination with entropy balancing, we offer empirical evidence that the adoption of inflation targeting together with high capital account openness can significantly reduce the reliance on foreign currency denominated sovereign international debt. We find that financially integrated inflation-targeting countries have 11 percentage points lower foreign currency shares in their sovereign debt compared to non-targeting countries. Second, we determine the threshold level of financial openness that countries need to attain before they see the full benefits of inflation targeting. Third, the joint effect of inflation targeting and capital account openness significantly increases three years after the policy implementation. Our results are robust to alternative specifications which include instrumental variables to account for the endogeneity of the policy.

How to Promote the Exchange Rate Marketization and Capital Account Liberalization in the Stage of High Quality Development of Economy? Empirical Evidence from 134 Economies

The promotion order between exchange rate marketization and capital account openness is one of the hotspots and debates in the field of international finance. Some scholars support the reform order of internal first, external next”, while others believe that they should be promoted in a coordinated manner. In view of the above two points, some scholars try to use econometric methods such as the Granger causality test and VAR model to determine the promotion order, but these methods are often limited to the selection of samples and depend on the data to a large degree, and different samples may draw different conclusions. Due to the lack of a reference system, the promotion order between exchange rate marketization and capital account openness is not determined. What is the basis or determination? The economic development level, total factor productivity or financial stability? If there is no basis, it is difficult to make a clear judgment on the promotion strategy. If the reference system is abandoned, the investigation only based on the data does not have practical significance. In view of this, this paper refers to the study of Rodriguez（2017）, constructs the influence equation of the exchange rate regime on total factor productivity（with capital account openness as the conversion variable）and the influence equation of capital account openness on total factor productivity（with the exchange rate system as the conversion variable）, respectively. Moreover, total factor productivity is selected as the reference system, and a non-linear modeling technology PSTR model is adopted to investigate the promotion strategy. It is revealed that the exchange rate regime has a significant non-linear effect on total factor productivity, the influence coefficient changes from negative to positive with the increase of capital account openness, which indicates that capital account openness can weaken the negative impact of exchange rate fluctuations on total factor productivity. The influence coefficient of capital account openness on total factor productivity is negative, and it shows obvious stage characteristics with the change of the exchange rate regime. When the exchange rate regime is flexible enough, its negative impact decreases significantly, which indicates that a more flexible exchange rate regime is conducive to absorbing the negative impact of capital account openness. Therefore, with total factor productivity as a reference system, there is a mutual adjustment mechanism between exchange rate marketization and capital account openness. Capital account openness is the premise of exchange rate marketization, and exchange rate marketization is also the prerequisite of capital account openness. They should be promoted in a coordinated way. Compared with the existing results, the possible contributions of this paper are as follows: First, the exchange rate regime and capital account openness are taken as the key explanatory variable and adjustment variable respectively, which enriches the literature with respect to the promotion order of exchange rate marketization and capital account openness, and overcomes the shortcomings of the existing literature that only employ one of them as the key explanatory variable and adjustment variable, making the research more comprehensive and detailed. Second, compared with most existing literature that directly adopt the interactive terms（only the first-order non-linear relations can be identified）, this paper utilizes a non-linear method—the PSTR model, which can identify higher-order non-linear relations and solve the problem of missing implicit non-linear relations. Third, compared with most existing literature focusing on economic growth or financial crisis, this paper conducts the analysis from the perspective of total factor productivity to re-judge the promotion order. The study can provide theoretical support and a decision-making basis for how to promote exchange rate marketization and capital account openness in the constitutive reform and transition from quantitative growth to qualitative development of China’s economic development.

Drawing the line: the politics of federal currency swaps in the global financial crisis

Injecting over two trillion dollars into the international economy, the Federal Reserve effectively operated as an international lender of last resort during the 2008 financial crisis. Over half a trillion dollars went to foreign central banks through bilateral arrangements known as Central Bank Liquidity Swaps. While studies show that a key determinant of a country’s chances of receiving Fed liquidity was the exposure of US banks to the foreign economy, the literature overlooks the ambiguous and politicized nature of the Fed’s decision-making that explains the selection of emerging market swap recipients. Through a consideration of all economies that officially requested a swap line, including those rejected, this article analyses the bilateral politics of Fed swaps. By evaluating transcripts of the Fed’s deliberations, it identifies strategic motivations underlying the Fed’s decision-making and argues the Fed was more likely to grant a swap to economies that shared its policy preferences for greater capital account openness. Further, the article argues that the influence of shared policy preferences was mediated by political and diplomatic considerations. The article concludes that the Fed strategically chose its emerging economy partners to reinforce economic alliances, particularly with those who experienced increased influence in economic governance post-2008.

Alternate instruments to manage the capital flow conundrum: A study of selected Asian economies

AbstractCapital inflows to and outflows from emerging market economies (EME) have increased significantly since 2000. This rapid increase, accompanied by a sharp rise in volatility, has amplified the complexity of macroeconomic management in EME. While foreign capital provides additional financing for productive investment and offers avenues for risk diversification, unbridled flows exacerbate financial and macroeconomic instability. In this paper, we focus on the experience of six emerging Asian economies (EAE) in dealing with capital flows. Using quarterly data, we identify the waves of capital flows experienced by these EAE and the efficacy of the various policy measures taken. The policy choices include negotiating the trilemma (i.e. balancing the need for monetary policy autonomy, exchange rate flexibility and capital account openness), as per the demands of the macroeconomic situation. The paper also analyses the extent to which intervention in the foreign exchange market and imposition of short‐term capital flow management measures have aided countries to negotiate the trilemma. The efficacy of these responses have been varied across countries, implying that a judicious mix of these measures, along with improvement in financial and institutional development, is required to effectively counter the vagaries of capital flows.

China and Special Drawing Rights—Towards a Better International Monetary System

China and the international monetary system need each other. The international monetary system is strained, with crisis just around the corner, yet reform is not on anyone’s agenda. Meanwhile China, deeply invested in the current system, faces narrowing options as trading partners question its moves abroad, debt levels rise at home, and its current account moves from surplus to deficit. RMB internationalization might appear to provide a way out, but the policy has its limits and tends to exacerbate rather than relieve tensions. We argue that a tension-reducing solution is at hand to the problems of both the international monetary system and China—IMF-style Special Drawing Rights (SDRs). If in a unilateral initiative China were to make the SDR central to its next phase of capital account opening, China’s institutions, corporates and individuals—presently restricted in their access to international currency—would likely embrace it. Begun by China, with support from the international community and Hong Kong, promulgation of the SDR would usher in an era of lower tensions, providing space for development and avoidance of conflict within a reordered monetary system in which China would have a more prominent role.

Demographics and interest rates in Asia

Demographic developments have been regarded as one important cause of the long-term movement in global interest rates. This paper provides empirical evidence of the relationship between demographics and interest rates over a wide sample of advanced and emerging market economies. It also finds that capital account openness limits the direct sensitivity of a country's interest rates to its own demographics. The results suggest that future demographic developments will continue to apply downward pressure on the interest rates in Asia which foresees a rapid aging.

Push vs. Pull Factors of Capital Flows Revisited: A Cross-country Analysis

Capital market integration contributes to economic growth and it can be more beneficial for emerging market economies (EMEs, hereafter) at their early stages of development where the capital is relatively insufficient. An open capital market also enables investor to share the country-specific risks by holding foreign assets. However, there are also some negative side effects of capital market integration. Financial shocks originating in the center country can be quickly propagated through the integrated financial market. The Global Financial Crisis (GFC, hereafter) is a good example of the contagion of the financial crisis. Volatile cross-border capital inflows and outflows negatively affect financial stability, which eventually lowers economic growth by causing financial crises. Despite of these negative side effects, capital market integration has been an inevitable long-term trend for many EMEs over the past few decades (Aizenman et al. 2010). There have been continuous capital flows to EMEs, which started even before GFC and this trend has been more pronounced during the U.S. zero-interest rate period (Ahmed and Zlate 2014). Though some monetary authorities in EMEs tried to moderate the procyclicality of credit flows by implementing policy instruments such as capital controls or macro-prudential policy measures after GFC (Kim and Mehrotra 2018), the common factors in the global financial market still play a crucial role in determining capital inflows to EMEs. The relationship between the global financial condition and its impact on capital inflows to EMEs, has been a long-debated issue. This issue concerns whether push or pull factors are the major determinant of capital flows. The push factor represents the common factor that exists in the global financial market or center countries, which influences capital inflows to peripheral countries. These factors are interest rates and GDP growth rates of advanced economies (AEs, hereafter), global risk factors such as VIX (S&P 500 Volatility Index), and the commodity price index. The pull factor denotes domestic factors that attract funds from the global financial market to domestic financial markets. These factors are domestic interest rates, domestic GDP growth rates, and other country-specific characteristics such as exchange rate regime, degree of the capital account openness, institutional quality, and stages of economic development. In previous literature, many scholars have found strong evidence for push factors being the major determinant of capital movement. The interest rates of mature economies and VIX are significant determinants of capital inflows to EMEs. However, there is only some evidence that higher domestic interest rates and higher domestic GDP growth rates pull capital from the center countries to individual EMEs (Koepke 2015). Related to this long-debated issue in academia, the Chairman of the Federal Reserve, Jerome H. Powell recently stated, ... I will argue that, while global factors play an important role in influencing domestic financial conditions, the role of U.S. monetary policy is often exaggerated. With this statement, he also pointed out that the slowdown in capital inflows to EMEs which has been happening ever since 2011 has been mainly due to the narrowing of GDP gaps between AEs and EMEs, i.e., the recent decrease in capital in-flows to EMEs can be attributed to the decline in EMEs' GDP growth rates given the fact that the U.S. GDP growth rate has picked up. In this paper, we revisit this issue of push and pull factors of capital inflows. To this end, we consider the heterogeneity that exists in EMEs by dividing them into four subgroups. We investigate which is the main driver of capital inflows between push and pull factors across country groups. Categorizing subgroups is important for two reasons. First, EMEs are so heterogeneous that we make subgroups which share similar economic fundamentals by regions. Second, making subgroups across EMEs is an effective way to indirectly consider the regional contagion effect. With this cross-country analysis, we can figure out the differing effects of push and pull factors across country groups, and this can eventually lead to the development and implementation of appropriate policy instruments. Our empirical finding shows that the push and pull factors play a different role in determining capital inflows to AEs and EMEs. The major drivers of capital inflows to AEs are both push and pull factors, but push factors turn out to be the main determinant of capital inflows to EMEs. When EMEs are divided into four subgroups, we find sizable heterogeneity across subgroups. In Asian countries, both push and pull factors are significant, which is similar to AEs, but only U.S. interest rate plays a major role in Eastern Europe. Some pull factors are important in Latin American countries and other EMEs, but these are not robust to alternative empirical models and measures.

Monetary policy divergence and net capital flows: Accounting for endogenous policy responses

This paper measures the effect of monetary tightening in key advanced economies on net capital flows around the world. Measuring this effect is complicated by the fact that the domestic monetary policies of affected economies respond endogenously to the foreign tightening shock. Using a structural VAR framework with quarterly panel data we estimate the impulse responses of domestic policy variables and net capital flows to a foreign monetary tightening shock. We find that the endogenous response of domestic monetary policy depends on each economy’s capital account openness and exchange rate regime. We use a method to compute counterfactual impulse responses for net capital outflows under the assumption that the domestic policy rate does not respond to foreign monetary tightening. Our results suggests that failing to account for the endogenous response of domestic monetary policy biases down the estimated elasticity of net capital flows to foreign interest rates by as much as one-third for countries with open capital accounts.

Foreign Direct Investment Absorption Capacity

We characterize the long-run foreign direct investment (FDI) absorption capacity by both direct and indirect methods on one cross-section data sample covering 180 economies from 1980 to 2013. The capacity is built up on productivity growth rate, savings–investment gap by the first approach and on financial development level by the second one. Two methods together reveal that deeper international financial integration by a higher capital account openness can expand substantially the foreign capital absorption capacity.

Industrial development factors: a comprehensive analysis of United States of America, European Union and China

A better functioning industrial sector matters directly for growth and contributes indirectly to poverty alleviation, unemployment reduction, trade promotion, exchange of goods and services, increased per capital income, GDP growth etc. in developing and developed economies. Nonetheless, after global financial crisis and fall of Bretton wood system a new debate was generated to re-examine the issue after the implementation of financial liberalization policies in these economies. Therefore, the central theme of this study is to test the industrial development nexus in United States of America, European Union and China. With this background in mind the present research aims to ascertain whether financial liberalization in terms of capital account openness (CAO), trade openness (TO), equity openness (EO), Regulatory factors in terms of World Governance indicator, private sector investment, public sector investment and lastly whether macroeconomic factors in terms of exchange rate (ER) and foreign direct investment (FDI) have had any impact on industrial development. Augmented dicker fully test was applied to estimate stationarity of data, vector auto regression, impulse response function and variance decomposition were used to describe shocks, after effects and magnitudes and intra and inter dependence of the study variables. EO, TO and FDI were significant determinants in European Union. However, Governance, TO and CAO are significant predictors in China and Lastly Governance, ER, FDI, private investment and public investment were significant in United States of America.

Financial Openness and Capital Inflows to Emerging Markets: In Search of Robust Evidence

We reassess the connection between capital account openness and capital flows in an empirical framework that is grounded in theory and makes use of previously unexplored variation in the data. We demonstrate how our theory-consistent regressions may overcome some ubiquitous measurement problems in the literature by relying on interaction terms between financial openness and traditional push-pull factors. Within our proposed framework, we ask: what can be said robustly about the effect of capital account restrictions on capital flows? Our results warrant against over-interpreting the existing cross-country evidence as we find very few robust relationships between capital account restrictiveness and various types of capital inflows. Countries with a higher degree of financial openness are more susceptible to some, but by no means all, push and pull factors. Overall, the results are still consistent with a complex set of tradeoffs faced by policymakers, where the ability to shield the domestic economy from volatile capital flow cycles must be weighed against the sources of exogenous risks and potential long run growth effects.

Liquidity Management under Fixed Exchange Rate with Open Capital Account

This paper introduces a theoretical framework for liquidity management under fixed exchange rate arrangement, derived from the price-specie flow mechanism of David Hume. The framework highlights that the risk of short-term money market rates un-anchoring from the uncovered interest rate parity due to money and foreign exchange market frictions could jeopardize financial stability and market development. The paper then discusses operational solutions that stabilize money market rates close to the level implied by the Uncovered Interest Rate Parity (UIP). Liquidity management under fixed exchange rate with an open capital account presents specific challenges due to: (1) the larger liquidity shocks induced by foreign reserve swings that challenge the development of money markets; and (2) more complicated liquidity forecasts. The theoretical framework is empirically tested based on the estimate of 'offset' coefficients for Denmark and Hong Kong SAR.

Liquidity Management Under Fixed Exchange Rate with Open Capital Account

This paper introduces a theoretical framework for liquidity management under fixed exchange rate arrangement, derived from the price-specie flow mechanism of David Hume. The framework highlights that the risk of short-term money market rates un-anchoring from the uncovered interest rate parity due to money and foreign exchange market frictions could jeopardize financial stability and market development. The paper then discusses operational solutions that stabilize money market rates close to the level implied by the Uncovered Interest Rate Parity (UIP). Liquidity management under fixed exchange rate with an open capital account presents specific challenges due to: (1) the larger liquidity shocks induced by foreign reserve swings that challenge the development of money markets; and (2) more complicated liquidity forecasts. The theoretical framework is empirically tested based on the estimate of “offset” coefficients for Denmark and Hong Kong SAR.